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The Market Monitor

All About Inflation

September was a challenging month for U.S. equities, especially technology stocks. The Dow tumbled 8.8%, while the S&P 500 fell 9.3% and the Nasdaq lost 10.5%. Q3 marked the third consecutive losing quarter for the S&P 500, bringing its year-to-date return through the end of September to -25%.

In recent weeks, bellwethers such as FedEx and Nike reported downbeat earnings. FedEx, which warned of a global recession and early signs of a slowdown in spending by Americans, saw its stock price fall 21% in its worst one-day performance ever. The company also withdrew its full-year guidance, citing the continued volatile operating environment. Nike, echoing comments from other retailers, attributed its disappointing profit expectations to continued supply chain issues and excess inventories.

The IPO window remains largely closed. The stock price performance of recent IPOs has been poor, with approximately 87% of companies that went public last year now trading below their IPO prices and the average 2021 IPO stock down 49% year to date through September 26, far worse than the S&P 500 Index return of -23% over the same period. On the bright side, Volkswagen completed its $9 billion IPO of Porsche at a $73 billion valuation, and a few high-profile companies such as Instacart and Mobileye are still considering 2022 listings. M&A activity also remains depressed, with M&A volumes down 63% in the U.S. in Q3 relative to the prior year. Private equity firms, which have funded hundreds of billions of dollars of M&A with cheap debt in recent years, are finding debt more scarce and expensive.

Public company CFOs are finding it more difficult to forecast their businesses in the current environment, and are widening forecasted revenue ranges and revisiting spending plans more often. And, while valuations have come down, CEOs remain reluctant to pull the trigger on M&A as the global economy appears headed into a recession. During this period of unusually high volatility, clear and consistent messaging is crucial. Equity investors are more focused on downside risk than usual, and management teams should be especially prepared to answer tough questions about costs, including stock-based compensation, and contingency plans for a likely recession.

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Month in Review

All About Inflation
After four decades of relative price stability in developed economies, until recently it seemed that the only people talking about inflation were academics, Wall Street economists, and an increasingly endangered species of investor who had been around long enough to have experienced firsthand the crushing inflation of the 1970s and early 1980s. Today, inflation seems to be all anyone can talk about, from Wall Street to Main Street to Washington, and nothing moves capital markets more than the latest inflation print. In announcing the Federal Reserve’s decision to raise interest rates by a further 75 basis points on September 21st, Chairman Jay Powell acknowledged that, while the chances of a “soft landing” scenario are diminishing, the central bank remains committed to bringing inflation down from 8.3% to its target rate of 2%. As a consequence of the Fed’s monetary policy tightening, the U.S. dollar has continued to strengthen, which is forcing foreign central banks, including those in the U.K., Europe, and Canada, to tighten monetary policy in their home currencies to keep devaluation in check. According to economists at Credit Suisse, this is creating the most rapid tightening in global monetary policy since 1989.

While this is bad news for stock prices, bond prices, and economic growth, it has proven to be excellent news for macro hedge funds, which are having a banner year. According to the Wall Street Journal, a class of the flagship fund of Bridgewater Associates, the world’s largest hedge fund with $150 billion of assets under management, was up 32.7% year to date through September 23rd, as compared to a 23.9% decline in the S&P 500 Index and a 4% decline for all hedge funds over the same period. Bridgewater and macro hedge fund peers such as Caxton Associates and the U.K.’s Brevan Howard tend to thrive during periods of high macroeconomic volatility. For the rest of us, we can only hope that the central bankers thread the monetary policy needle without tipping the global economy into a major recession.
Mixed Signals
While the consequences of higher rates are immediately felt in certain areas of the economy, their impact can take time to work their way through the economy as a whole. Due to its dependence on mortgage financing, the housing market has been one of the hardest-hit sectors in recent months as mortgage rates have spiked to 14-year highs. According to a recent survey by John Burns Real Estate Consulting, only 15% of 197 homeowners who said they were saving to buy a home said they would be willing to take on a new mortgage rate of 6% or higher. With the average 30-year fixed mortgage rate hovering at around 6.8%, housing market activity is likely to continue to decline. On the other hand, the labor market remains strong with unemployment at 3.7% and companies like Starbucks announcing enhanced benefits to retain employees and Instacart planning to focus its IPO on employee shares to retain top tech talent. There are reasons to suspect that the strength in the job market may not be sustainable, however. Companies need more workers today in part because workers simply aren’t producing as much as they used to. U.S. non-farm labor productivity fell at a seasonally adjusted annual rate of 4.1% in the second quarter from the prior quarter, according to the Labor Department, after dropping 7.4% in the first quarter, the sharpest drop in 74 years. And, according to Gallup, 50% of the U.S. workforce is “quietly quitting,” or doing the bare minimum job requirements to remain employed. We will see if this practice remains sustainable as the Fed continues to use monetary policy to tamp the breaks on economic growth and HR managers respond to quiet quitters by “quietly firing” them.
ESG Blowback
With spiraling energy costs in Europe and still-high gas prices in the U.S., critics of ESG investing are coming out of the woodwork. Were it not for the influence of ESG-focused investors, the story goes, Western oil & gas companies may have invested more in production capacity which would have reduced Russia’s influence on European energy markets and reduced prices at the pump here in the U.S. Republican politicians such as Florida Governor and potential 2024 Presidential candidate Ron DeSantis have banned ESG considerations from state pension investments. In announcing the Florida ban, DeSantis effectively articulated the ethos of the budding anti-ESG movement: “With the resolution we passed today, the tax dollars and proxy votes of the people of Florida will no longer be commandeered by Wall Street financial firms and used to implement policies through the board room that Floridians reject at the ballot box. We are reasserting the authority of republican governance over corporate dominance and we are prioritizing the financial security of the people of Florida over whimsical notions of a utopian tomorrow.” Bill Gates, not exactly a favorite in Republican circles, is sounding a different alarm. “We’re in a worse place than I expected,” according to Gates, as the effects of the pandemic and the war in Ukraine have dramatically slowed progress on ESG-related initiatives such as the UN’s sustainable development goals. While most believe that ESG investing is here to stay, and ESG funds have suffered proportionately lower outflows than other types of pooled funds in recent months, the anti-ESG movement at the very least bears watching.

Lighter Notes

  • Messy, at Best. Snap’s mass layoff of 1,200 people in September (20% of its full-time workforce) didn’t quite go to plan. Assuming there was a fully baked plan, that is. CEO Evan Spiegel attributed the various snafus, which included laid off employees being locked out of the corporate network before they were able to access their email accounts to see whether or not they had actually been laid off, to “IT issues.” Perhaps the company should have considered communicating the layoffs over a public messaging platform such as… well, Snap?
  • Don’t Just Do Something, Stand There. Shoji Morimoto, a 38-year-old Tokyo resident, has what those disinclined to activity view as the perfect job: he gets paid to basically do nothing. For $71, a customer can pay to have a silent companion at a restaurant, a see-saw partner, a stranger to smile and wave at them out of a train window, or a nearly infinite variety of other roles that involve little to no work. It is unclear whether Mr. Morimoto was inspired by the 1999 classic, Office Space.
  • Counting Sheep. The growth in photovoltaic solar installations in the U.S. is benefiting an unlikely segment of the workforce: shepherds. Their voracious flocks are incredibly efficient consumers of the grasses that grow under and around solar installations and must be cleared to ensure that sunshine is not blocked from hitting the panels. Graze on that.
  • High 5-0. Maryland police hosted a “pot party” as part of their Green Labs program to show marijuana enthusiasts how much the weed impairs driving. In what must have been one of the more awkward parties ever, 10 marijuana-enthusiast guests brought joints, blunts, edibles, vape pens and at least one bong, and were given free chips and pizza by the cops in return for submitting to impairment tests. The things people do for free pizza!
  • Dairy Queen. The winner of the Minnesota State Fair’s “Princess Kay of the Milky Way” beauty pageant receives an unusual award: her likeness carved into a 90-pound block of butter. What to do with such a rich bounty? This year’s winner, Rachel Rynda, plans to melt down her butter head and throw a special event for all her supporters. She also plans to make Christmas cookies with the scraps she received. We just hope Rachel’s friends are lactose-tolerant!
Hurricane Ian left a path of destruction on Florida’s San Carlos Island
Hurricane Ian
Image Credit: Cristobal Herrera-Ulashkevich/Shutterstock

Chart Series

Deeper and Deeper. The spread between 2-year and 30-year Treasury yields, often used as a proxy for the yield curve, hasn’t been this negative since 2000. An inverted yield has preceded every recession since the 1970s.
2-10 Spreads
Priced Out. Due to spiking mortgage rates and continued home price appreciation, the median monthly mortgage payment in Q2-22 was 1.44x the median monthly asking rent, the largest differential on record.
Rent vs Mortgage (2)
London Falling. The British Pound fell to its lowest level against the dollar since 1985 as Great Britain’s Prime Minister and Chancellor of the Exchequer unveiled a plan for tax cuts and higher spending.
Bearish. According to the BofA Global Fund Manager Survey of 212 participants with $616 billion under management in the week through Sept. 8, the net % of respondents expecting a recession has reached the highest since May 2020.
BAML Fund Manager Survey

By The Numbers

  • $10 trillion: combined assets held by JPMorgan Chase, Bank of America, and Citigroup, about 50% more than 5 years ago (NYT)
  • $5 trillion: increase in deposits in the U.S. banking system in the past 2 years due to pandemic-related stimulus (WSJ)
  • $2.8 trillion: amount Russia’s war in Ukraine will cost the global economy by the end of next year (OECD)
  • $1.5 trillion: economic toll of the opioid addiction and overdose crisis on the U.S. in 2020, according to a Congressional report (Reuters)
  • $1.2 trillion: estimated investment in renewable energy by 2035 (Wood Mackenzie)
  • $1.137 trillion: amount of U.S. revolving consumer credit at the end of July, a record and up 11.6% year over year (Federal Reserve)
  • $456 billion: the value U.S. office buildings stand to lose due to lower tenant demand (Columbia University and New York University)
  • $315 billion: amount lost by tech billionaires in 2022, though their net worth remains higher than before the pandemic (Recode)
  • $100 billion: amount India’s Adani Group plans to invest over the next decade, most of it in the company’s energy transition business (Reuters)
  • $73 billion: the effective U.S. government investment in the semiconductor industry through the CHIPS Act, including $30 billion of direct investments in leading-edge manufacturing capacity and $6 billion of loans or loan guarantees (NYT)
  • $60 billion: estimated upper limit of total losses related to Hurricane Ian, nearly all of which are in Florida (Verisk)
  • $9.1 billion: amount raised by Porsche in its $75 billion IPO (Reuters)
  • $8.9 billion: debt load of UK-based cinema chain Cineworld (#2 worldwide and owner of Regal Cinemas) at the time of its bankruptcy filing (NYT)
  • $4.13 billion: fine levied on Alphabet by the EU for using its Android mobile operating system to thwart rivals (Reuters)
  • $1.8 billion: fine paid by more than a dozen financial firms, including eight major Wall Street banks, for failing to monitor their employees’ use of private apps and personal devices to discuss work matters (Reuters)
  • $900 million: amount paid by Biogen to settle claims that it paid kickbacks to doctors to encourage them to prescribe its drugs (NYT)
  • $700 million: amount lost by Wall Street banks on a $16.5 billion loan to fund the LBO of Citrix (Reuters)
  • $450 million: amount Amazon will set aside for higher wages and benefits for delivery drivers employed by members of its Delivery Service Partners network (WSJ)
  • $300 million: amount that the members of the band Genesis, including Phil Collins, agreed to sell rights to their music for to Concord Music Group (WSJ)
  • $250 million: amount allegedly stolen from a federal program that fed low-income children by 47 people in what Justice Department officials called the largest theft yet uncovered from a coronavirus pandemic aid program (WSJ)
  • $200 million: amount Boeing agreed to pay to settle an SEC investigation related to 737 MAX crashes. Former CEO Dennis Muilenburg agreed to pay $1 million (WSJ)
  • 22 million: jobs lost early in the pandemic and since regained (WSJ)
  • 10 million: streams on Amazon for “Poopy Stupid Butt” as musicians target toddlers in Alexa households (BuzzFeed)
  • 7.4 million: acres burned each year over the past decade, up from 3.4 million annually in the 1990s (National Interagency Fire Center)
Hundreds and Thousands
  • 500,000: decrease in the U.S. workforce due to COVID (MIT)
  • 126,228: acres for drilling leased by the Interior Department under the the Biden administration, making him the first president since Richard Nixon to be short of 4.4 million acres at this point (WSJ)
  • 78,000: number of workers who went on strike in the first six months of this year, up from 26,500 in the same period last year (Cornell University School of Industrial and Labor Relations)
  • $66,000: average cost of a new electric car in the U.S. last year — just a few thousand dollars less than the median household income (NYT)
  • $460: increase in average spending for the same basket of goods and services as compared to last year (Moody’s)
  • 240: number of companies in the S&P 500 mentioning “recession” on their earnings calls in Q2, the most ever in FactSet’s data going back to 2010
Singles and Doubles
  • 70: number of years since the last bear market in global government bonds (Deutsche Bank)
  • $1.033: U.S. dollars required to buy 1 British Pound on September 26th (a 37-year low) after Chancellor Kwasi Kwarteng's tax cuts rattled investors (Euronews)
  • 92% of participants in the Bank of America survey now expect profits to decline in the next year
  • 90%+ of the world’s ships are insured through a London-based association of insurers, according to Bruegel, a Brussels-based think tank
  • 84%: decline in the year-over-year mortgage refinance volumes for the week ended September 23. Purchase mortgage volume declined 29% year-over-year (MBA)
  • 77% of American small businesses said inflationary pressures had increased over the past three months, hurting their ability to hire and expand as customers cut back (Goldman Sachs survey)
  • 60% of small companies said worker shortages are affecting their ability to operate at full capacity, according to a September survey of more than 725 small-business owners (Vistage Worldwide)
  • 47.5%: office use as a % of early 2020 levels for workers in the office over the five business days from Sept. 8 to Sept. 14 in 10 major metro areas, the highest percentage since late-March 2020 (Kastle Systems)
  • 30% of SoftBank’s Vision Fund unit employees are expected to be laid off (Bloomberg)
  • 20%: efficiency improvement sought by Alphabet CEO Sundar Pichai (CNBC)
  • 17%: percentage of Britons who think Lizz Truss will be a better Prime Minister than Boris Johnson, with 25% believing she will be worse (Reuters)
  • 16.1%: median wage increase for recent job changers, compared with 7.6% for those who stayed in the same jobs (ADP)
  • 15%: percentage of homeowners who said they were saving to buy a home who said they would be willing to take on a new mortgage rate of 6% or higher (John Burns Real Estate Consulting)
  • 10%: Eurozone inflation in September, up from 9.1% in August and above consensus projections of 9.7% (Eurostat)
  • 9.57%: average junk bond yield (Bloomberg)
  • 6.82%: average 30-year fixed mortgage rate as of September 30 (Bankrate)
  • -4.1%: Q2 seasonally adjusted annualized decline in U.S. nonfarm labor productivity relative to Q1, after dropping 7.4% in the first quarter, the sharpest drop in 74 years (U.S. Labor Department)
  • -5.3%: change in the S&P 500 Index in Q3, bringing the year-to-date decline to nearly 25% (CNBC)
  • -5.5%: percentage point change in Q3 analyst earnings growth estimates since June 30, the biggest cut since Q2 2020 (FactSet)
  • -63%: change in U.S. M&A volume in Q3 compared to the prior year (Reuters)
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